'Marginal’ borrower activity critical to financial stability: RBA

Monitoring what “marginal” borrower groups are doing is more important to financial stability than the actions of “average” borrowers, the Reserve Bank of Australia has said.

In a speech made in Sydney in August, RBA assistant governor Christopher Kent said that the activity of marginal borrowers was critical to Australian financial stability.

Articulating the relationship between interest-only borrowers and offset accounts, Mr Kent said that many owner-occupiers with interest-only (IO) loans were behaving like clients with principal and interest (P&I) loans. “That is, many of those borrowers have built up significant balances in offset accounts,” he said.

“If needed in times of financial stress — such as a period of unemployment — borrowers could use those balances to service their mortgages.”

But, while drawing a line between the “strong growth” in offset balances in the years leading to 2015 and a corresponding growth in the share of IO loans, Mr Kent cautioned against suggesting that “this similarity regarding the build-up of financial buffers means that the tightening of lending standards for interest-only loans was not warranted”.

“Far from it,” he said. “What matters when it comes to financial stability is not what the average borrowers are doing, but what the more marginal borrowers are doing.”

Mr Kent explained that investors have a greater share of loans with loan-to-value ratios (LVR) of 75 per cent or higher, and that this was especially true for IO loans, reflecting the financial incentive for investors in maximising the amount of funds borrowed.

However, he added that this number “doesn’t account for offset accounts”, which have grown “rapidly” in recent years and which play an important role in the Australian home loan market.

“Funds held in these accounts are ‘offset’ against the loan balance, reducing the interest payable on the loan. In that way, they are similar to a principal repayment. But, unlike the scheduled principal repayment, offset (and redraw) balances can be moved in and out freely by the borrower,” Mr Kent said.

He continued: “Part of the strong growth in offset balances up to 2015 appears to have been related to the rise in the share of interest-only loans, with the two being offered as a package.

“Interestingly, we saw a significant slowing in growth in offset balances around the same time as growth in interest-only housing loans started to decline.”

In spite of the body of offset balances, there is a “noticeable” share of loans with LVRs of between 75 per cent and 80 per cent, Mr Kent said.

He highlighted that for both owner-occupier and investor loans, “adjusting for offset balances leads to only a small change in the share of loans with current LVRs greater than 80 per cent”.

“This suggests that borrowers with high current LVRs have limited repayment buffers,” he added.

Mr Kent concluded that while many IO borrowers had accumulated “sizeable” offset balances, current LVRs still tended to be larger than for principal and interest borrowers.

Arrears by region

In the same speech, Mr Kent said that mortgage arrears have increased “more noticeably” in regions exposed to falling commodity prices or a downturn in mining investment.

He suggested that rates of arrears are determined by factors that include, but aren’t limited to, unemployment. He further made the observation that, despite mortgage arrears rates increasing “slightly” over the recent years, they have increased “more noticeably” in regions exposed to the downturn in commodity prices and mining investment.

While there is a relationship between rates of arrears and unemployment, Mr Kent noted that RBA data showed that the relationship “is not especially strong, which suggests that other factors are at play”.

He pointed to higher rates of arrears in mining-exposed regions that have seen a severe fall in demand following the mining investment boom.

Mr Kent said: “One indicator of that [relationship] has been the pronounced fall in the demand for housing in those parts of the country, as indicated by a decline in housing prices.”